For example, suppose your team hired a celebrity quarterback who is well-liked and unusually lucky but can’t throw the ball very far. You’ve agreed to pay him $6,000,000 over three years. And suppose that you spend hundreds of thousands of dollars on training to teach him to throw the ball, and he still can’t seem to learn to throw the ball very far. Even if he sprains his ankle during the pre-season and can’t play ball all season, you still have to pay him $6,000,000.
Sometimes you have already committed yourself to paying sunk costs (such as this football contract). Other times, you have already spent the money, and feel committed to keep your investment, even though it was a losing bet.
You pay $1,000,000 for a small office building to house your new business. Suddenly, new “cloud” technology allows you to put most of your operations on the web. Should you stay off the cloud, and use the building anyway? Should you keep the building empty until you need more space?
Sunk costs sometimes trap business people into thinking that they should “make good” on their investments, instead of dumping them and moving on.
The common error is to think that sunk costs can be changed when, in fact, they can’t.
For example, suppose you spent four years in college studying archaeology. After you graduate, you can’t find a job. What do you do? Don’t quit! You spent too much time and money on your education to give up. Keep looking for a job! Or do you go back to college to learn something else?
The four years of time and money (the sunk costs) are gone. No amount of job-hunting or persistence will bring them back. If you are looking for income, learn something new and get a real job.
Here are other ways that sunk costs fool us into doing the wrong thing:
- We continue to use older technologies that were very expensive, when newer technologies are more effective and productive.
- We “throw good money after bad” by fixing old machinery that could have been replaced for less money.
- We continue to waste retail and production space with old, unprofitable products, instead of focusing on products with greater potential.
- We raise employees to their “highest level of incompetence,” instead of hiring new employees with the skills and expertise that we need.
- We ignore new opportunities, hoping that older declining operations will “turn around.”